An Emergency Fund Will Help Reduce Your Risk Of Financial Catastrophe

A couple of years ago if you had asked me what I would do if an emergency presented itself and I needed some money quickly, I would probably have told you, “That’s what credit cards are for!”. Just put it on the card and pay it off when you can! Emergencies aren’t really something you can plan for, so why try to plan for them, right?

Emergencies do have a way of coming up at the most inopportune times, but the fact is that you CAN plan for emergencies. You may not know when they’ll hit, or how hard they’ll hit. But you do know that they will happen. So it’s best to plan for them while you can.

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Since we started our financial plan a year or two ago and saved up an emergency fund we have seen many family emergencies pop up. We have gone through an emergency hospitalization where my wife was in the hospital for a month with a blood clot. We had a car accident. We had a car broken into and had a lot of stuff stolen from us. And now we’re preparing for another medical emergency where my wife will be having another unplanned surgery next week.

If this doesn’t prove it to you, nothing will. You WILL have emergencies pop up in your life, so get ready!

Reasons To Set Up Your Emergency Fund

Emergencies Happen: The more time goes on, the more you realize that things do come up that you hadn’t planned for, and you’re going to have to pay for them. You’ll be on vacation and get a bad case of the flu. Traveling to grandma’s house when the tire blows out. Things happen, and they won’t happen at a convenient time.

It Relieves Stress: When you have an emergency fund saved, it has an added built in bonus. Peace of mind! You’ll feel the weight lifted off your shoulders because you no longer have to worry about most small emergencies. Once you get your larger emergency fund saved, you won’t have to worry about paying for most large ones either.

It Reduces Risk: When you have an emergency fund (along with other things like health insurance, disability insurance and life insurance), you have a lot less risk of bad things happening. You’re much less likely to go into bankruptcy, foreclosure or to start accumulating large amounts of debt. In other words you’re making sound decisions to plan for problems, before they happen.

Where Should I Save My Emergency Fund?

One question that always comes up every time you talk about emergency funds is, “where you should I put this money?”. Put it in CDs? Bonds? Money market account? High-yield online savings?

Personally, I think it’s first and foremost important that you keep your money as liquid as possible. You want to be able to access it when an emergency comes up! You don’t want to be scrambling trying to convert your bonds back to cash, or waiting 3 months for your CDs to mature. Put it in a good high yield (not as high these days) savings account where you can get at it ASAP! Some good account options that I would suggest:

There are other good options out there of places to keep your savings, but just make sure that the account is readily accessible, and your money liquid.

How Much Money Should I Be Saving In My Emergency Fund?

When we started saving our emergency fund we followed Dave Ramsey’s 7 Baby Steps plan found in his “Financial Peace University” class. I think it’s a good plan to follow so I’ll outline the steps a bit here.

The first step in his plan is to save $1000 for a baby emergency fund. The idea is to have a small buffer for most emergencies that come up, so you don’t have to go further into debt (if you have debt). Most small emergencies like flat tires, needing a new alternator or a doctor’s office visit will be covered by this small emergency fund.

The second step in the Dave Ramsey’s plan is to get out of debt using the debt snowball. Getting rid of your debt is integral to improving your situation, and in this step you get intense about finding extra work, doing a budget and living on less than you make so that you can cut into your debt.

The third step is to build up your emergency fund from your starting position of $1000, all the way up to 3-6 months of expenses. To figure out how much that is you’ll need to do a family budget, figure out how much money NEEDS to be spent every month, and use number to figure out how much 3-6 months of savings will be. For some people 6 months of expenses will be $18,000. For others it might be closer to $30,000. It all depends on your personal situation.

So how much money should I save, and when?

Start a $1000 baby emergency fund.

Pay off all debts.

Save 3-6 months of expenses. ($15,000-$30,000 in most cases?)

In our current economic climate some people are even suggesting that you save 8-12 months of expenses. This would be especially pertinent if your job situation is a bit unstable, and you’re expecting a layoff soon. I would certainly have no problem with that, and would even encourage it if you really do feel like you’re in imminent danger of losing a job.

When Should We Spend Our Emergency Savings?

Another question that often comes up is, “What constitutes an emergency, and when should we spend our money in our emergency fund?”.

This is a question that you’ll need to answer for your own family at your family budget meeting. Generally, however, an emergency fund should be used for large unplanned expenses that you would otherwise have to go into debt for. Things like replacing blown tires on your car, or fixing your furnace in the dead of winter or paying for an emergency room visit.

Things you shouldn’t use your emergency fund for include things like a vacation to Hawaii, that diamond ring you’ve been coveting, and that awesome new game system that all your friends have. Things that you don’t really need should not be paid for by emergency funds.

Comments

I agree about the emergency fund. I will take the $1000 rule a bit farther though. If I had a $1500 dollar deductible for my house/car insurance, I would want $1500 dollars in my emergency fund. Of course, I would rather pay the extra $10 a year to keep my deductible lower.

But its a good idea to have a family meeting to ID what constitutes an emergency though. I may implement that into my life since we hadn’t really defined an ‘emergency’ for us.

We’ve accumulated about 6mos of expenses in our emergency fund (about $20,000) and it’s kept in a high-interest savings account. Thankfully we haven’t had any emergencies so far that would require us to dip into the fund.

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